Friday, June 27, 2014 - Biscuits on the Table

Biscuits on the Table
by Sinclair Noe

DOW + 5 = 16,851
SPX + 3 = 1960
NAS + 18 = 4397
10 YR YLD  + .01 = 2.53%
OIL - .10 = 105.74
GOLD – 1.80 = 1316.10
SILV - .25 = 20.97

The major stock indices traded lower for most of the day, and only in the final minutes turned to positive territory. For the week, the Dow slipped 0.6 percent and the S&P 500 declined 0.1 percent, while the Nasdaq gained 0.7 percent. Volume spike today as the Russell Indices were reconstituted.

The Russell Indices are compiled by Russell Investments. The Russell 3000 is an index of the 3000 largest stocks in the US. The Russell 2000 is the 2000 smallest stocks in the Russell 3000. Once a year, the Russell indices are reconstituted, to reflect changes such as acquisitions, bankruptcies, or just changes in the size of the companies listed in the index. The reconstitution probably explains the increase in volume and the last minute increase in prices today.

Some things we need to know heading into the weekend; including Ukraine, Iraq, and Argentina. We’ll start with the situation in Ukraine. The European Union signed a free-trade pact with Ukraine today and warned it could impose more sanctions on Moscow unless pro-Russian rebels act to wind down the crisis in the east of the country by Monday. Georgia and Moldova signed similar deals, holding out the prospect of deep economic integration and unfettered access to the EU's 500 million citizens, but alarming Moscow which is concerned about losing influence over former Soviet republics.

EU leaders meeting in Brussels demanded that, by Monday, Ukrainian rebels agree to ceasefire verification arrangements, return border checkpoints to Kiev authorities, free hostages and launch serious talks on implementing Ukrainian president Poroshenko's peace plan.

EU leaders said they were ready to meet again at any time to adopt significant sanctions on Russia. Diplomats said they could target new people and companies with asset freezes as early as next week. More than 60 names are already on the list. Although it has drawn up a list of hard-hitting economic sanctions against Russia, the EU is still hesitating over deploying them because of fears among some member states of antagonizing their major energy supplier.

Meanwhile, leaders of the European Union's 28 member states voted on the next president of the European Commission, which serves as the EU's executive branch. The president sets the policy agenda, enforces rules and represents Europe abroad. They elected Jean Claude Junker on a 26-2 vote. The losing votes belonged to the United Kingdom and Hungary, and they really have a strong dislike for Junker; so much so that they may try to exit the EU. That probably won’t happen, but there is talk of an “in or out” referendum for the Brits.

A funny thing is happening in Iraq. The US is lining up support for Iraq from Iran and Syria. And the bombing has apparently started, but we’re still trying to figure out who is throwing the bombs. The first aerial bombing took place Monday or Tuesday, apparently carried out by the Syrian Air Force, acting at the behest of the Iranian government in support of the Iraqi government, which the US government supports, but only if the Iraqi’s purge the government of all the goofs who messed up over the past 10 years or so.

Which is to say, the war in Iraq is escalating. Already, the war involves Iraq, Syria, Iran, Turkey, Saudi Arabia, Qatar, ISIS or ISIL if you prefer, Israel, Lebanon, and of course the US. The Pentagon denied reports of US drone strikes along the Iraq-Syria border after reports by BBC of drone bombings. The Murdoch Street Journal reports Syrian airstrikes. Unidentified bombers have reportedly launched an air strike on ISIS positions in northern Iraq. Iraqi television has claimed they are US planes, but the Pentagon has denied responsibility.

US planes were identified by Iraqi television, but the Saudi Al-Arabiya network claims that the raid was carried out by Syria. Meanwhile, Iranian Special Forces sent in to help protect Baghdad and a few select holy sites, along with surveillance drones. And Israel has bombed Syria in retaliation for an attack from Syria that killed Israeli civilians in the Golan Heights.

And so with all this going on, the Pentagon admitted yesterday that armed US drones are now flying over Iraq, equipped with Hellfire missiles, deployed from a base in Kuwait, in addition to unarmed surveillance flights by drones and manned aircraft, and supplemented by US military advisers on the ground.

Meanwhile, the Pentagon says the United States has opened a "joint operations center" in Baghdad, boosting the total number of US service members to 500. And the New York Times reports that Iraqi government officials are saying that the US is planning to send more than 1,000 private security guards to Iraq to protect US troops, which amounts to far more than the US government has previous acknowledged.

For years Iraq has been a major oil producer; it kept Saddam in business all those years; back then Iraq produced about 2.5 million barrels a day; recently output has increased to more than 3 million barrels, and it’s estimated that production could easily top 6 million barrels. In a country of about 30 million, there should be enough natural resources for profound prosperity, but that is not the case. In recent years, none of this oil wealth trickled down to the grassroots, especially in Sunni areas of the country where signs of reconstruction, economic development, restored services, or jobs were hard to find. Instead, the vast new revenues disappeared into the recesses of a corrupt government, and from there – who knows?

So here’s where Iraqi oil, or the lack of its revenues at least, comes into play. Communities across Iraq, especially in embittered Sunni areas, began demanding funding for reconstruction, often backed by local and provincial governments. In response, the Maliki government relentlessly refused to allocate any oil revenues for such projects, choosing instead to denounce such demands as efforts to divert funds from more urgent budgetary imperatives. That included tens of billions of dollars needed to purchase military supplies including, in 2011, 18 F-16 jets from the United States for $4 billion. In a rare moment of ironic insight, Time magazine concluded its coverage of the F-16 purchase with this comment: “The good news is the deal will likely keep Lockheed’s F-16 plant in Fort Worth running perhaps a year longer. The bad news is that only 70% of Iraqis have access to clean water, and only 25% have clean sanitation.”

My grandmother used say, as long as we’ve got biscuits on the table, nobody should go hungry. I guess they never heard that saying in Iraq.

Nothing in today's complex world has a single cause, but you have to think that a major reason for all this is the oil.

Argentina is in trouble. They have until Monday to pay a group of hedge fund managers over $1.3 billion on defaulted bonds. If they don’t pay, they risk default. If it goes into default, investors lose faith in Argentina’s capacity to pay, interest rates on its bonds surge, and the country is forced to print money to pay creditors, the economy could collapse.

Then again, if Argentina does pay this group of hedge fund managers over $1.3 billion worth of bonds by July 30, it opens itself up to lawsuits from other investors who also own those bonds, lawsuits that could cost the country up to $15 billion. That's over half the money it has in its central bank.

The story goes back to 2001, when Argentina was going through a financial crisis. Argentina issued bonds, and they defaulted on those bonds. After the default, hedge fund manager Paul Singer and some other hedge funds swooped in to buy the defaulted bonds for pennies on the peso. They knew they were buying defaulted bonds, but the idea was that things might improve or there might be a deal negotiated; that’s what usually happens, debt issuers restructure debt, and negotiate with creditors to pay less. Creditors usually take the deal because it is better to get something rather than nothing. Most of Argentina’s creditors have decided to accept 70 cents on the dollar.

But Paul Singer is demanding 100% face value of the bonds. And if he is not paid, there is a clause that says no other creditors can be paid. And if Argentina pays the full amount to Singer, the other creditors will likely not be satisfied with a 70% haircut. And the reason Argentina is in this jam is because Singer sued, and it went all the way to the US Supreme Court, and the Supremes sided with the hedge funds, and let stand a district court ruling.

The Supreme Court has been busy handing down decisions this week; and we will likely get a couple more decisions on Monday; I guess they don’t hand down decisions on Friday, and opt instead for an early happy hour. Anyway, the decisions of the past week were downright strange for one reason; several were unanimous. Wednesday, the court decided Riley v. California, which unanimously held that police cannot search the cellphones of people they arrest without a warrant. On Thursday, the court handed down two of its major opinions of this year: National Labor Relations Board v. Noel Canning, about the president's recess appointment power and McCullen v. Coakley, about abortion clinic buffer zones.

You will recall that the court is split ideologically, with 5 justices leaning right and 4 justices leaning left, so it’s a little surprising to see the twain meet. Unanimity is rare; a fractured court is the norm, and yet, we had three unanimous decisions among people who are inclined to disagree; and at a time when the House of Representatives is suing the president and people from one side can’t have a civil conversation with someone from the other side. Maybe this is an example of the rule of law being more important than politics. Before we declare a victory for compromise, maybe there’s a little more to how the court arrived at unanimity.

Even when the court agrees on a ruling, it can divide over the reasoning and even how the rule should be applied. In other words they take very different paths to arrive at the same place. It is possible that a 5-4 decision is not an indication of a polarized court. You have to read the decisions behind the vote. And conversely, a unanimous decision can mask deep divisions that appear down the road.

Monday, June 16, 2014 - Manic Monday

Manic Monday
by Sinclair Noe

DOW + 5 = 16,781
SPX + 1 = 1937
NAS + 10 = 4321
10 YR YLD - .01 = 2.59%
OIL - .12 = 106.79
GOLD – 4.20 = 1272.70
SILV un = 19.77

It’s Monday, and that means mergers. Today’s acquisition news comes from Medtronics, the medical device maker, announcing it will acquire Covidien for nearly $43 billion. Medtronics was founded in a garage in Minneapolis in 1949, but they will change their headquarters to Ireland, which is where Covidien has been headquartered since 2009. Covidien is actually a Massachusetts company, and they operate out of Massachusetts. Medtronics will continue to operate out of Minneapolis; the whole deal is about a lower tax rate, and for Medtronics, the ability to repatriate $20 billion in offshore profits, without paying tax.

Meanwhile, the IPO market remains white hot, and 14 companies will come to market this week. So far this year 124 companies have priced in the US, up 57% from a year ago. Total proceeds raised come to $25.8 billion, up almost 41% from 2013.

Data today showed industrial production climbed more than forecast in May. Output at factories, mines and utilities rose 0.6% after a revised 0.3% drop in April that was smaller than previously estimated. In a separate report, the New York Fed’s Empire manufacturing report rose to 19.28, better than expectations.

The Fed FOMC meets later this week to determine monetary policy. After their meeting concludes Wednesday, Fed officials will release their updated projections for interest rates, growth, inflation and unemployment, and also are likely to trim their bond-buying program by an additional $10 billion a month.

The latest report from the International Monetary Fund, the IMF, might suggest the Fed doesn’t need to be in a hurry to exit a Zero Interest Rate Policy. Of course, the IMF doesn’t set Fed policy, but the latest IMF forecast for the US economy cuts the outlook for growth to 2% from the 2.8% predicted back in April; the lower forecast is mainly a result of the weakness in the first quarter. The IMF kept if 2015 forecast unchanged at 3%. The forecast says the economy is starting to rebound but will remain below historical averages as the population ages and productivity growth slows. Their forecasts show we won’t return to full employment until the end of 2017, with inflation remaining low.

The IMF suggests the US raise the minimum wage as one way to boost the economy; other suggestions include more spending on infrastructure and education, plus changing parts of its tax system, including boosting the federal gasoline tax and reinstating the tax credit for research and development, to help spur growth. In the future, policymakers should also reform corporate taxes, introduce a carbon tax and move toward a federal value-added tax.

IMF Director Christine Lagarde says the oil shock that could result from the current tension in Iraq might affect the economy but for that to happen, the shock would have to be rather deep and rather long-lasting. You’ll probably start seeing the price increase at the pump, as prices hover just below $107 a barrel. And oil prices are being whipsawed by the headlines; if we see fighting in Baghdad, we could easily see prices pop up to $120 a barrel.

Iraq, excluding the Kurdish region, holds 150 billion barrels in proven crude reserves, the world’s fifth-biggest deposits. A pipeline from the Kirkuk region to Turkey has been shut down since March, and now Kurdish troops are defending the Kirkuk oilfields from ISIL rebels. Even if the rebels are turned back, the Iraqi government in Baghdad may have a hard time displacing Kurdish troops in the future.

Meanwhile, Ukraine said Russia cut natural gas supplies after demanding fuel payments be made in advance, the first time shipments have been affected in this year’s crisis in relations between the two countries. Tensions escalated over the weekend with 49 servicemen killed when pro-Russia fighters shot down an aircraft.

British climate change economist Lord Nicholas Stern says our current models “grossly underestimate” the economic damage that will be wrought by climate change. In 2006 Stern wrote a scientific paper that estimated the externalized costs of burning fossil fuels will impact the world economy by five per cent to 20 per cent of global GDP, which would work out to between $2.3 trillion and $9.1 trillion each year. Now, Stern says he “got it wrong on climate change; it’s far, far worse.”  So, Stern and a colleague, Simon Dietz just published a new preliminary paper that makes a few key updates, and now Stern believes that “climate change is the greatest markets failure the world has ever seen.”

The old model looks at any point in time, measures the economy’s productive capacity, and then gauges how much climate change will dampen that productivity in that moment. But climate change can also reduce that productive capacity itself. Stronger storms can damage infrastructure; sea level rise can force people to abandon homes, businesses or equipment; and climate damage can channel more investment into repairs and away from creating new capital. Stern and Dietz account for that, and the result is a double hit: at any given moment, the effects of climate change are reducing the economy’s ability to produce wealth, but they’re also reducing the economy’s overall capacity to produce wealth at future moments.

Other factors in modeling climate change’s economic effects are what scientists call “tipping points”; moments when global warming kicks off feedback loops in the planetary ecology that cause the effects to speed up. Examples of tipping points include the polar ice melting in a way that results in sudden huge collapses rather than gradual melting; or melting permafrost in the northern hemisphere releasing underground methane that in turn speeds up global warming even more. They can also include second-order social effects that damage economies: drought and food scarcity kicking off wars or mass refugee movements, for instance.

June is a big month for the Supreme Court and several major rulings are expected in the next few weeks, and some cases have already been decided.

Last Thursday, the Supremes announced opinions on only two of the 22 cases it has in front of it: POM Wonderful v. Coca-Cola which deals with whether a company can sue another one for unfair competition based on false or misleading product descriptions; and Clark v. Rameker, which weighs whether individual retirement account (IRA) inheritance can be exempted from Chapter 7 bankruptcy under the “retirement funds” exemption.

In the POM case, the court ruled that POM, a company that makes pomegranate juices, had the right to sue Coca-Cola for falsely advertising one of its juices as being made mostly of pomegranate and blueberry juice when it was actually made of apple and grape juices. POM, which makes a special pomegranate-blueberry juice blend, claimed it lost sales as a result of Cola-Cola’s false labeling. The ruling reversed a decision from the Ninth Circuit Court of Appeals, which essentially said POM lacked the legal standing to sue because of a conflict with state and federal law.

In Clark v. Rameker, the court ruled that IRA inheritance funds do not meet the “retirement funds” exemption and must be included as part of the estate in the bankruptcy process. Because an IRA is intended for the retirement of the person who originally put the funds into the account, and an inherited IRA functions essentially as a fund that can be used at any time and not just for retirement, the exemption does not apply.

Today, the Supreme Court handed Argentina two major defeats in cases brought by bondholders who refused to accept reduced payments after the country’s 2001 default. The Supremes decided against hearing Argentina’s appeal of an order requiring it to pay holders of defaulted notes from 2001 when making payments on its restructured debt. The next payment on those bonds comes due June 30. Shortly after the first decision, the Supremes handed down another ruling allowing the bondholders to issue subpoenas to banks in an effort to trace Argentina’s assets abroad.

The inaction by the Supreme Court is a victory for the minority of investors, led by a hedge fund controlled by billionaire Paul Singer, who have refused to exchange their defaulted bonds for about 30 cents on the dollar. Argentina calls those investors “vultures” because they bought many of the bonds post-default at a discount, angling to eventually collect a windfall; in other words, they bought the bonds for pennies on the dollar, refused to accept 30 cents on the dollar, and the Supremes say they now must be paid the full face amount of the bonds.

In response to today’s decisions, lawyers for Argentina wrote: “Since Argentina lacks the financial resources to pay the holdouts in full (what would amount to $15 billion) while also servicing its restructured debt to 92 percent of bondholders, Argentina will have to face, objectively, a serious and imminent risk of default.”

Argentina claimed that lower-court rulings misread Argentina’s bond agreements and violated its immunity as a sovereign nation. In court filings, the Argentine government has said it would comply with lower-court rulings. But in public pronouncements, Argentine President Cristina Fernández de Kirchner has vowed not to pay a group of creditors she has referred to as “predators.”

Also today, the Supremes dealt a rare blow to the gun lobby Monday by ruling that purchasers must report when they are buying firearms for other people.

Other rulings expected this week might include Sebelius v. Hobby Lobby, which deals with whether a for-profit company has to provide contraceptive care for its employees if the owner has a religious objection, even though the employees are entitled to it through the Affordable Care Act (ACA), also known as Obamacare.

Also, American Broadcasting Company v. Aereo, which should be of interest if you watch TV over the internet. Aereo is a Web startup company that allows consumers to pay an $8 or $12 subscription fee to watch their local TV networks live on any Internet-connected device. The major broadcasters say this amounts to theft of their product.

And a couple of cases that deal with the Fourth Amendment: Riley v. California, and United States v. Wurie; both cases are about whether the police have to obtain a warrant to search an individual's cellphone when an arrest is made.

Wednesday, February 19, 2014 - Stake your Claim

Stake your Claim

by Sinclair Noe

DOW – 89 = 16,040
SPX – 12 = 1828
NAS – 34 = 4237
10 YR YLD + .02 = 2.73%
OIL + .81 = 102.91
GOLD – 11.40 = 1311.90
SILV - .43 = 21.64

This winter has been brutally cold for much of the country, the worst in 20 years. The harsh weather makes an easy scapegoat for slow economic growth and sickly earnings. Every bad bit of economic data and all ugly earnings reports can be buried under the snow and ice. Many companies and sectors aren’t really affected by the weather; while others were definitely slammed.

This is true of new construction. The Commerce Department reports housing starts dropped 16% to 880,000 in January from 1.05 million in December. For all of 2013, builders began work on 926,700 homes, up the most since 2007’s 1.36 million. The good news is that the weather related downturns will eventually melt away like so much ice on a warm sidewalk.

Another report today showed producer prices increased 0.2% in January, led by gains in goods such as food and pharmaceuticals. This follows a 0.1% increase in the PPI in December. Today’s data mark the debut of the PPI after its first major overhaul since 1978, which more than doubles its reach of the economy by including prices received for goods, services, government purchases, exports, and construction. The revamped PPI encompasses 75% of the economy, up from a third of all production for the old index, which reflected the costs of goods alone.

Since services represent the biggest part of the economy, the gauge will offer a broader look at inflation at the producer level. Goods will account for about 24% of the new PPI gauge; while service, including financial services, food wholesalers and transportation providers, make up 63%; prices of government purchases and exported goods represent 11%; construction is 2%. What this new methodology might do is to smooth out inflation at the wholesale level because goods are inherently more volatile than services. What the report reveals is that we are experiencing disinflation.

So, those were the two economic reports of the morning, and the Dow Industrial average was rolling along with about 50 points in gains, then we saw the minutes of the January Federal Reserve FOMC meeting. Fed officials agreed unanimously to continue to slowly reduce the pace of its asset-purchase program by another $10 billion to $65 billion per month and to pledge to keep rates low until “well past” the point where the unemployment rate fell below a 6.5% threshold. This was the first unanimous statement since 2011. And that’s about where the unanimity ended.

A few Fed hawks thought it might be good to increase short term rates within the next few months; a few Fed doves thought it might be good to slow down the pace of the taper; that brought a response that there should be a “Clear presumption in favor of continuing to reduce the pace of purchases by a total of $10 billion at each policy-making meeting, especially if there is no evidence of a change in the outlook.” The debate on changing the forward guidance, the pledge to the market about keeping rates low, was all over the map. Some want to lower the unemployment rate threshold, while others want a more descriptive or “qualitative” guidance.

And the Fed policy makers described the weak December jobs report as an “anomaly”. Now, remember that the FOMC meeting took place just a few days before the weak January jobs report; so I suppose we could describe that as a double anomaly. If there is a third consecutive weak jobs report for February, then I think we might call it egg on the face. The bottom line is that for now, the taper is on track, rates will remain low for at least a year, we’ll have plenty of forward guidance, and Janet Yellen’s job is something like herding cats.

There are a couple of interesting court cases; one involving Argentina and the other, Detroit.

The country of Argentina has asked the US Supreme Court to review a case that has unsettled the Argentinian markets and currency and might force the country to make payments on billions of dollars of defaulted bonds.

The dispute stems from Argentina’s 2001 default on $95 billion in debt. The country offered to substitute bonds worth 25 cents to 29 cents on the dollar in 2005 and made a similar proposal in 2010. Owners tendered about 92 percent of the outstanding debt. NML Capital, a fund run by billionaire Paul Singer, swooped in and bought about $1.5 billion in bonds for pennies on the dollar, and then they did not accept the swap, opting instead to go through the courts. NML sued to collect the full amount, citing a clause in the bond agreement bars Argentina from treating the restructured securities more favorably than the defaulted bonds.

Argentina challenged a lower court ruling that said the country must pay owners of the repudiated bonds in full before it can make payments on a separate $24 billion in restructured debt. The legal fight has put US courts in the unusual position of shaping another country’s financial future. Argentina says the dispute threatens to force a new default, and lower court rulings have led to credit ratings downgrades. The Argentines further argued that the lower court rulings “effectively reach into Argentina’s borders, coercing it into violating its sovereign debt policies and commandeering billions of dollars of core sovereign assets.”

The appeals court rulings in the case are on hold while the Supreme Court decides whether to get involved. Some decision is expected from the Supremes by around April. Argentina previously said it would never pay the funds, which the country’s leaders have called “vultures.” Its legislature passed a law in 2005 barring payment on the defaulted bonds. Another option under consideration is that the country will offer a new restructuring plan to defaulted bondholders and let investors who own the restructured notes swap them into debt subject to local law.

Meanwhile, Detroit is as broke as Argentina. Lawyers are arguing over how to split the money that’s left. A lawyer for the city says Detroit’s general obligation tax pledge doesn’t give bondholders priority over other creditors in its record $18 billion municipal bankruptcy. Bond insurers have sued Detroit, claiming a proposal by the city’s emergency manager to cut payments to general obligation bondholders is illegal. The insurers say that pledges the city made when the bonds were issued give bondholders certain rights over the taxes.

The dispute may require the judge to weigh in on a long-running debate among legal scholars about whether certain municipal bonds get priority over more traditional unsecured creditors, such as public employees or suppliers. The city’s lawyer argued the city’s pledges to bondholders are no different from those made to all unsecured creditors. Such general promises mean the municipal bonds in dispute are unsecured. Detroit didn’t set aside any property that could be used as collateral for the bonds, or create a special lien on the taxes. The current offer would pay public employee pensions 25 cents on the dollar and GO bond holders 22 cents. The bond insurers present their case in a couple of days.

The city may also try again to resolve a dispute over interest-rate swaps that cost taxpayers about $4 million a month. Detroit may present a new proposal for canceling the swaps in the next three or four days.

While historic winter storms have battered much of the US, California is suffering its worst drought on record. The reservoirs of California are just a fraction of capacity. In the dried-up fields of California's Central Valley, farmers are selling their cattle. Others have to choose which crops get the scarce irrigation water and which will wither.

California is the biggest agricultural state in the US - half the nation's fruit and vegetables are grown here. Farmers are calling for urgent help, people in cities are being told to conserve water and the governor is warning of record drought.

Meanwhile, the southern Imperial Valley, which borders Mexico, draws its water from the Colorado River along the blue liquid lifeline of the All American Canal. Farmers are making hay while the water flows, alfalfa actually; which is used as cattle feed and is being exported to China.  In effect, a hundred billion gallons of water per year is being exported in the form of alfalfa from California. It's a huge amount. It's enough for a year's supply for a million families.

Cheap water rights and America's trade imbalance with China make this not just viable, but profitable. We have more imports than exports so a lot of the steamship lines are looking to take something back. And hay is one of the products which they take back. It's now cheaper to send alfalfa from LA to Beijing than it is to send it from the Imperial Valley to the Central Valley.

Japan, Korea and the United Arab Emirates all buy Californian hay. The price is now so high that many local dairy farmers and cattle ranchers can't afford the cost when the rains fail and their usual supplies are insufficient. Hay trucks are a common sight heading north up the road from the Imperial Valley and despite the high prices, the cattle farmers have to buy what they can. Even with recent rains in northern California there's still a critical shortage of water. There will be many questions about who has claim to what, and this is just the early stages of the drought. Stay tuned.